Currency Demonetisation Likely to Hurt Indian Homebuilders’ Sales

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Singapore/Mumbai: Fitch Ratings says that the Indian government’s recent move to demonetise currency notes of higher denominations is likely to have a negative impact on homebuilders, at least in the next 12-24 months. India has a significant cash-based economy, and therefore considerable undeclared income in circulation, and the government’s move is likely to severely curtail the use of any undeclared income which is usually retained in the form of cash or invested in property and gold.

We expect residential property prices and property sales to fall, as consumers attempt to work out how best to declare their wealth. The regulation stipulates that they have to exchange old currency notes into those with lower denominations or new current notes, by 30 December 2016. The regulation comes at a time when there are hints of increased scrutiny of income-tax evasion, and follows closely on the heels of the tax amnesty scheme which expired on 30 September 2016.

The negative impact is likely to be more pronounced on sales of higher-end, premium property which is targeted by high-net-worth individuals and investors, rather than entry-level housing targeted by first-time homebuyers which are more often purchased by salaried individuals with limited undeclared income. Therefore homebuilders with greater exposure to large-ticket premium property projects are likely to be the most affected. Furthermore, we expect homebuilders more exposed to projects in the National Capital Region (NCR) to be hit more than in other regions, because NCR is known to have a greater reliance on cash-based transactions.

The negative impact on cash collections of homebuilders such as Indiabulls Real Estate Limited (IBREL, B+/Stable) and Lodha Developers Private Limited (B/Negative) may be slow initially, because a considerable portion of their cash collections in the next three to six months is likely to stem from previously sold properties. However risks to these companies may increase, as consumers are likely to take more than a few months to adjust to the new environment. The pace of project execution across the wider real-estate sector may also experience a slowdown at least until the industry adjusts to the new paradigm. Project executions may be slower – particularly for new and existing projects that have a significant number of pending regulatory and local government approvals.

However, we expect that the curtailing of undeclared wealth in the economy will be supportive of the real-estate sector over the longer term, as it is likely to improve affordability and bring about greater transparency.

Government announced on 8 November that the currency notes in denominations of INR500 and INR1,000 would no longer be legal tender, from midnight. These notes will now need to be exchanged for existing lower denominations notes or new INR500 and INR2,000 notes at banks and post offices, until 30 December 2016. Based on the latest government economic survey, only about 4% of Indian adults (or around 51 million people) file income-tax returns, and of this only around 13 million people are estimated to have paid income tax for the fiscal year 2014-2015. A four-month government tax amnesty ending on 30 September 2016 has brought in some USD10bn of undeclared wealth via around 64,200 new declarations.